Nonbusiness Bad Debts: Basic Rules

Sometimes a person owes you money and never pays it back. For tax purposes, that may be a bad debt. Publication 550 (2025), Investment Income and Expenses, explains how to deduct one. This guide is general information. It is not advice about your return.

Two kinds of bad debts

The publication says there are two kinds of bad debts: business and nonbusiness. A business bad debt comes from your trade or business. All other bad debts are nonbusiness bad debts. The publication says nonbusiness bad debts are deductible as short-term capital losses.

The publication gives an example. An architect made personal loans to several friends who were not clients. The architect could not collect on some of them. Those losses are nonbusiness bad debts, because the architect was not in the business of lending money and the loans had no relationship to the architect's business.

The debt must be totally worthless

You can deduct a nonbusiness bad debt only when it is totally worthless. The publication says you cannot deduct a partly worthless nonbusiness debt. A debt becomes worthless when there is no longer any chance the amount owed will be paid.

You do not have to wait until the due date. You do not have to go to court if you can show that a judgment would be uncollectible. You must show that you took reasonable steps to collect the debt. The publication says a debtor's bankruptcy is generally good evidence that at least part of an unsecured debt is worthless.

A real loan, not a gift

The debt must be genuine. A genuine debt comes from a true creditor and debtor relationship, based on a valid obligation to repay a fixed sum of money. You must show that you meant to make a loan when you made the transaction, not a gift.

If you lend money to a relative or friend with the understanding that it may not be repaid, the publication treats it as a gift. You cannot take a bad debt deduction for a gift. The publication also says that when minor children borrow from their parents to pay for basic needs, there is no genuine debt.

You must have a basis in the debt

To deduct a bad debt, you must have a basis in it. That means you already included the amount in your income, or you loaned out your cash. For example, you cannot deduct court-ordered child support that a former spouse did not pay you.

Most individuals use the cash method. The publication says cash method taxpayers generally cannot deduct unpaid wages, rent, interest, dividends, or similar amounts that they never included in income.

Debts you agree to cover

If you agree to be responsible for someone else's debt, and that debt becomes worthless, you cannot deduct your payments on it. The exception is when you agreed to cover the debt to protect an investment or with a profit motive. If you agreed as a favor and got nothing in return, your payments are a gift.

When to deduct it

You deduct the bad debt in the year it becomes worthless. If you did not deduct it on your original return, you can amend that year with Form 1040-X. The publication says you must file within 7 years from the date the original return for that year had to be filed, or 2 years from the date you paid the tax, whichever is later.

How to report it

Report the bad debt on Form 8949, Part I, line 1. In column (a), enter the name of the debtor and "bad debt statement attached." Enter your basis in column (e) and zero in column (d). Use a separate line for each bad debt. Check box C, the box for short-term transactions not reported on Form 1099-B.

Attach a statement to your return for each bad debt. The publication says the statement should include:

• A description of the debt, including the amount and the date it became due.
• The name of the debtor, and any business or family relationship between you and the debtor.
• The efforts you made to collect the debt.
• Why you decided the debt was worthless.

Simple steps

1. Confirm the money was a loan, not a gift.
2. Confirm you have a basis in the debt.
3. Confirm the debt is totally worthless, and note the year.
4. Keep records of the amount, the due date, your collection steps, and why the debt is worthless.
5. Report it on Form 8949, Part I, with the statement attached.

Deposits lost in a bank or credit union that became insolvent or bankrupt have their own rules. Read the publication before you choose a treatment.

For related rules, see our guide to the capital loss limit and carryover. Our guide to the wash sale rule covers another capital loss rule.

Upload your documents and answer a few simple questions to start your return.

Sources: Sources: IRS, Publication 550 (2025), Investment Income and Expenses (https://www.irs.gov/pub/irs-pdf/p550.pdf) This is general information, not advice about your specific return.

← Back to the blog · Leer en español